MFS Losing Faith in Argentina as Default Vultures Circle

Billionaire Paul Singer’s hedge fund Elliott Management Corp. is among creditors that refused to take part in restructurings after the government defaulted on $95 billion of debt in 2001 and are demanding compensation from the Argentine government. Photographer: Jacob Kepler/Bloomberg

April 15 (Bloomberg) -- MFS Investment Management, manager
of the oldest U.S. mutual fund and an ally of the Argentine
government in its legal fight against disgruntled creditors, is
reducing holdings of the South American nation’s debt.

MFS has sold about $194 million of its dollar-denominated
Argentine government bonds issued as part of the nation’s debt
restructurings since November, when Chief Operating Officer
Robin Stelmach said the firm owned over $390 million in
principal of the notes, according to Feb. 28 company filings
compiled by Bloomberg. The notes have lost 0.3 percent since the
end of October, compared with an average 2.8 percent gain for
emerging-market bonds, according to JPMorgan Chase & Co.

The company located in Boston is part of the Exchange
Bondholder Group, an alliance of investment firms that also
includes BlackRock Inc. and Gramercy Funds Management LLC that
joined the nation in challenging a U.S. court order that would
reward holdout creditors with face value and accrued interest.
MFS is cutting back ahead of the U.S. appeals court ruling that
could trigger further losses in the bonds.

“The current bondholders are essentially being used as
cheese to bait the mousetrap,” Matthew Ryan, who helps manage
$18 billion of emerging-market debt at MFS, said in a telephone
interview from Boston. “This is a risk that’s much more
difficult for a real money investor to assess.”

Potential Default

Ryan and MFS spokesman John Reilly declined to comment on
the firm’s holdings or the outcome of the litigation.

The legal battle risks a potential default on the
restructured notes because the lower court also blocked the
government from servicing those securities without making the
$1.3 billion payment to investors. Billionaire Paul Singer’s
hedge fund Elliott Management Corp. is among creditors that
refused to take part in restructurings after the government
defaulted on $95 billion of debt in 2001 and are demanding
compensation from the Argentine government.

Alfredo Scoccimarro, an Argentine presidential spokesman,
didn’t reply to an e-mail seeking comment on the potential for
default or support from bondholders.

MFS, which is owned by Toronto-based insurer Sun Life
Financial Inc. and manages about $349 billion, bought
Argentina’s defaulted debt before the first restructuring in
2005, according to Ryan. The firm accepted the new bonds in a
swap that was valued at about 30 cents on the dollar.

MFS Holdings

Fourteen of MFS’s funds held a total of about $390 million
in principal of Argentina’s restructured bonds in the week after
a U.S. federal appeals court in New York said on Oct. 26 that
Argentina must treat all of its bondholders equally. The most
recent company filings show that nine of those funds still own
the securities, which total about $196 million in principal.

The funds sold about $54 million in principal of so-called
discount bonds due 2033, $121 million of bonds due 2038 and $18
million of global bonds due 2017, according to the filings.

The notes plunged 11 percent on Feb. 28, the day after
Argentina’s attorney, Jonathan Blackman, told the appellate
judges the nation would not “voluntarily obey” an order to pay
holders of defaulted bonds in full, spurring concerns the nation
would opt to default on its outstanding notes.

The dollar-denominated restructured bonds have an average
yield of 13.54 percent, and investors demand an extra yield of
11.41 percentage points to own the notes over U.S. Treasuries,
the most among 55 developing nations in JPMorgan’s EMBI Global
index.

Sell Recommendations

JPMorgan and Bank of America Corp. recommend investors sell
the bonds and remain underweight in their portfolios.

“Argentina’s morphing from an indexed real-money
investment to an off-index hedge-fund investment because of the
volatility and risk profile,” Siobhan Morden, the head of Latin
America fixed-income strategy at Jefferies Group Inc., said in a
telephone interview from New York. “MFS and these other
bondholders are still held accountable to their own investor
base and they have to limit their mark-to-market risk.”

Thomas Wagner, co-founder of New York-based hedge fund
Knighthead Capital Management LLC, part of a separate group of
exchange bondholders in support of Argentina that hold euro-denominated bonds, said on April 5 that the nation’s debt is
undervalued.

“The legal battle notwithstanding, it looks like it’s
extraordinarily mispriced relative almost to any sovereign in
the world,” Wagner said on Bloomberg Television’s “Market
Makers.”

Debt Burden

Argentina’s public debt is equal to 41.6 percent of the
country’s gross domestic product, compared with 54.9 percent in
Brazil, which pays an average interest rate of 3.7 percent to
borrow abroad, according to data compiled by Bloomberg and
JPMorgan.

AllianceBernstein LP, which also joined the exchange
bondholder group, sold $70 million of euro-denominated discount
bonds in its Global High Yield Portfolio since the beginning of
November, according to the most recent company filings compiled
by Bloomberg. The firm added about $1 million in principal of
dollar-denominated restructured bonds in that period through its
Emerging Market Debt fund and High Income Fund, filings show.

As Argentina’s legal battle persists, bondholders will see
attractive returns should the court rule in Argentina’s favor or
should the U.S. Supreme Court agree to hear the case, said Jack
Iles, who helps oversee about $2 billion in emerging-market debt
at Manulife Asset Management.

‘Potential Upside’

Discount bonds have fallen 20 cents since the day before
the October court ruling to 60.25 cents on the dollar, according
to data compiled by Bloomberg. Bonds due 2038 have lost 3.3
cents to 34.53 cents on the dollar, and global bonds due 2017
have lost 21.4 cents to 78.24 cents on the dollar.

“The potential upside is definitely outweighing the
downside,” Iles, who helps oversee about $2 billion in
emerging-market debt, said in a telephone interview from Boston.
His funds sold their Argentine sovereign debt holdings, he said.
“If you get any kind of positive news these bonds will pop and
that’s probably why people won’t sell a whole position but sit
on a certain balance of it.”

The cost to protect $10 million of Argentine debt against
non-payment during five years with credit-default swaps rose 206
basis points to 2,159 basis points on April 12, according to
data compiled by CMA Ltd. The swaps pay the buyer face value in
exchange for the underlying securities or the cash equivalent
should a borrower fail to adhere to its debt agreements.

‘Very Weak’

Money managers invested $6.3 million in Argentine bonds in
the seven days ended April 10, 34 percent of the amount in the
last week of October, according to Cambridge, Massachusetts-based research company EPFR Global. Weekly inflows into
emerging-market debt funds were $729 million, EPFR data show.

MFS is being prudent, according to Diego Ferro, co-chief
investment officer at Greylock Capital Management LLC.

“Evidently, from a purely legal perspective, Argentina’s
position seems very weak,” Ferro said in a telephone interview
from New York. “One thing is to support Argentina, another is
to think it’s going to win.”